In a communication it published on 21 September 2017, the European Commission set out several options for taxing companies that are active in the digital economy. What would these options mean for your business? This ‘Tax Bit’ is the second in a series in which we assess all the options the Commission has put forward.
The first Tax Bit in this series assessed the suggested ‘Equalisation tax on the turnover of digitalised companies. Please also see our note, “Taxing the digital economy under discussion in the EU”, for more background information.
Option II – Withholding Tax on Digital Transactions
One of the short-term options the European Commission has set out is a withholding tax on digital transactions—a “standalone gross-basis final withholding tax on certain payments made to non-resident providers of goods and services ordered online”. In its BEPS Action 1 final report, “Addressing the Tax Challenges of the Digital Economy”, the OECD also noted that a “withholding tax on payments by residents (and local PEs) of a country for goods and services purchased online from non-resident providers” was also under consideration, and mentioned two options for imposing it:
- as a “standalone gross-basis final withholding tax on certain payments made to non-resident providers of goods and services ordered online”
- as a “primary collection mechanism and enforcement tool”—that is, “as net-basis taxation”
The report noted that each option could face “technical issues” having to do, among other things, with what transactions would be covered and just how taxes would be collected.
It is worth noting in this connection that, for its part, the European Commission has yet to flesh out details in a number of key areas, notably regarding just which types of transactions this option would cover. This absence of detail makes it difficult to come up with a full-fledged assessment of this option. Nevertheless, based on what we do know so far we can set a number of initial pros and cons.
It would seem that levying this tax only on digital transactions involving payments to non-resident taxpayers would entail discrimination of a kind that would violate the EU freedom to provide services. However, EU case law give the EU Parliament broader discretion than individual Member States enjoy, and it is only in cases of ‘manifest error’ that the Court of Justice will declare a tax measure to be in breach of a given EU freedom. A withholding tax levied solely on payments to non-resident taxpayers would likely not qualify as such a “manifest error”.
Another potential problem has to do with how the tax would be collected. If it were levied solely on business-to-business (B2B) transactions, it would be possible to withhold it from the payer. In the case of business-to-consumer (B2C) and consumer-to-consumer (C2C) transactions, intermediaries could see to collection as part of a mandatory registration system for non-resident enterprises that have a local bank account. Two major hurdle would need to be addressed under this option: the administrative burden it could create, and the cost to individuals and/or intermediaries. Each of these could jeopardise the development of certain sectors of the digital economy.
Finally, a tax on digital transactions could result in arbitrary taxation. Why should a product or service ordered be taxed differently, depending on whether it is purchased online or through some other channel? Such arbitrariness could in turn lead to market distortions. Moreover, arbitrary differences in taxation tend, predictably enough, to result in manipulation by taxpayers seeking to be taxed in the most favourable way.
Which companies active in the digital economy would be impacted should this proposal become law?
The answer to this question depends on a number of factors. The first is the scope of transactions that the tax would cover:
- It could target the online sale of specific goods or services such as films, music, and travel, or it could be imposed only those sales that are made online.
- It could target one or more of the following kinds of transaction:
- B2B transactions, such as online advertising services, or data-collection and -analysis services
- B2C transactions, such as online retail sales
- C2C transactions, such as those that take place in an online marketplace).
In this last case, it might be difficult to determine which jurisdiction should count as the consumer jurisdiction.
The risk of double taxation
A second factor has to do with how a new withholding tax on digital transactions would fit into the international tax framework. At the moment, tax treaties help prevent double taxation in cases where a withholding tax is levied on dividends, interests or royalties. A new tax on digital transactions would probably not be covered by existing treaties. To prevent double taxation, then, a new mechanism would have to be devised and accepted, not only by the countries introducing the new withholding tax, but also by all of their treaty partners.
As at the time of writing, this last option does not appear to have much support. Most EU Member States either favour a long-term solution based on amending existing concepts such as permanent establishment, or are pushing for quick fixes such as an equalisation tax.